benefits. It’s property rights that make such calculations possible and that induce people to take into account the effects of their actions on others. And it’s markets, that is, the opportunity to engage in free exchange of rights, that allow all of the various parties to calculate the costs of actions.
Negative externalities such as air and water pollution are not a sign of market failure, but of government’s failure to define and defend the property rights on which markets rest.
8. The More Complex a Social Order Is, the Less It Can Rely on Markets and the More
It Needs Government Direction
Reliance on markets worked fine when society was less complicated, but with the tremendous growth of economic and social connections, government is necessary to direct and coordinate the actions of so many people.
If anything, the opposite is true. A simple social order, such as a band of hunters or gatherers, might be coordinated effectively by a leader with the power to compel obedience. But as social relations become more complex, reliance on voluntary market exchange becomes more—not less—important. A complex social order requires the coordination of more information than any mind or group of minds could master. Markets have evolved mechanisms to transmit information in a relatively low-cost manner; prices encapsulate information about supply and demand in the form of units that are comparable among different goods and services, in ways that voluminous reports by government bureaucracies cannot. Moreover, prices translate across languages, social mores, and ethnic and religious divides and allow people to take advantage of the knowledge possessed by unknown persons thousands of miles away, with whom they will never have any other kind of relationship. The more complex an economy and society, the more important reliance on market mechanisms becomes.
9. Markets Don’t Work in Developing Countries
Markets work well in countries with well developed infrastructures and legal systems, but in their absence developing countries simply cannot afford recourse to markets. In such cases, state direction is necessary, at least until a highly developed infrastructure and legal system is developed that could allow room for markets to function.
In general, infrastructure development is a feature of the wealth accumulated through markets, not a condition for markets to exist, and the failure of a legal system is a reason why markets are underdeveloped, but that failure is a powerful reason to reform the legal system so it could provide the foundation for the development of markets, not to postpone legal reform and market development. The only way to achieve the wealth of developed countries is to create the legal and institutional foundations for markets so that entrepreneurs, consumers, investors, and workers can freely cooperate to create wealth.
All currently wealthy countries were once very poor, some within living memory. What needs explanation is not poverty, which is the natural state of mankind, but wealth. Wealth has to be created and the best way to ensure that wealth is created is to generate the incentives for people to do so. No system better than the free market, based on well defined and legally secure property rights and legal institutions to facilitate exchange, has ever been discovered for generating incentives for wealth creation. There is one path out of poverty, and that is the path of wealth creation through the free market.
The term “developing nation” is frequently misapplied when it is applied to nations whose governments have rejected markets in favor of central planning, state ownership, mercantilism, protectionism, and special privileges. Such nations are not, in fact, developing at all. The nations that are developing, whether starting from relatively wealthy or relatively impoverished positions, are those that have created legal institutions of property and contract, freed markets, and limited the powers, the budget, and the reach of the state power.
10. Markets Lead to Disastrous Economic Cycles, Such as the Great Depression
Reliance on market forces leads to cycles of “boom and bust” as investor overconfidence feeds on itself, leading to massive booms in investment that are inevitably followed by contractions of production, unemployment, and a generally worsening economic condition.
Economic cycles of “boom and bust” are sometimes blamed on reliance on markets. The evidence, however, is that generalized overproduction is not a feature of markets; when more goods and services are produced, prices adjust and the result is general affluence, not a “bust.” When this or that industry expands beyond the ability of the market to sustain profitability, a process of self-correction sets in, and profit signals lead resources to be redirected to other fields of activity. There is no reason inherent in markets for such correction to apply to all industries; indeed, it is self-contradictory (for if investment is being taken away from all and redirected to all, then it’s not being taken away from all in the first place).
Nonetheless, prolonged periods of general unemployment are possible when governments distort price systems through foolish manipulation of monetary systems, a policy error that is often combined with subsidies to industries that should be contracting and wage and price controls that keep the market from adjusting, thus prolonging the unemployment. Such was the case of the Great Depression that lasted from 1929 to the end of World War II, which economists (such as Nobel Prize winner Milton Friedman) showed was caused by a massive and sudden contraction in the money supply by the U.S. Federal Reserve system, which was pursuing politically set goals. The general contraction was then deepened by the rise in protectionism, which extended the suffering worldwide, and prolonged greatly by such programs as the National Recovery Act, programs to keep farm prices high (by destroying huge quantities of agricultural products and restricting supply), and other “New Deal” programs that were aimed at keeping market forces from correcting the disastrous effects of the government’s policy errors. More recent crashes, such as the Asian financial crisis of 1997, have been caused by imprudent monetary and exchange rate policies that distorted the signals to investors. Market forces corrected the policy failures of governments, but the process was not without hardship; the cause of the hardship was not the medicine that cured the disease, but the bad monetary and exchange-rate policies of governments that caused it in the first place.
With the adoption of more prudent monetary policies by governmental monetary authorities, such cycles have tended to even out. When combined with greater reliance on market adjustment processes, the result has been a reduction in the frequency and severity of economic cycles and long-term and sustained improvement in those countries that have followed policies of freedom of trade, budgetary restraint, and the rule of law.
11. Too Much Reliance on Markets Is As Silly As Too Much Reliance on Socialism: the
Best is the Mixed Economy
Most people understand that it’s unwise to put all your eggs in one basket. Prudent investors diversify their portfolios and it’s just as reasonable to have a diversified “policy portfolio,” as well, meaning a mix of socialism and markets.
Prudent investors who don’t have inside information do indeed diversify their portfolios against risk. If one stock goes down, another may go up, thus evening out the loss with a gain. Over the long run, a properly diversified portfolio will grow. But policies aren’t like that. Some have been demonstrated time and time gain to fail, while others have been demonstrated to succeed. It would make no sense to have a “diversified investment portfolio” made up of stocks in firms that are known to be failing and stocks in firms that are known to be succeeding; the reason for diversification is that one doesn’t have any special knowledge of which firms are more likely to be profitable or unprofitable.
Studies of decades of economic data carried out annually by the Fraser Institute of
Canada and a worldwide network of research institutes have shown consistently that greater reliance on market forces leads to higher per capita incomes, faster economic growth, lower unemployment, longer life spans, lower infant mortality, falling rates of child labor, greater access to clean water, health care, and ot
her amenities of modern life, including cleaner environments, and improved governance, such as lower rates of official corruption and more democratic accountability. Free markets generate good results.
Moreover, there is no “well balanced” middle of the road. State interventions into the market typically lead to distortions and even crises, which then are used as excuses for yet more interventions, thus driving policy one direction or another. For example, a “policy portfolio” that included imprudent monetary policy, which increases the supply of money faster than the economy is growing, will lead to rising prices. History has shown repeatedly that politicians tend to respond, not by blaming their own imprudent policies, but by blaming an “overheated economy” or “unpatriotic speculators” and imposing controls on prices. When prices are not allowed to be corrected by supply and demand (in this case, the increased supply of money, which tends to cause the price of money, as expressed in terms of commodities, to fall), the result is shortages of goods and services, as more people seek to buy limited supplies of goods at the below-market price than producers are willing to supply
The Economics of Freedom: What Your Professors Won't Tell You, Selected Works of Frederic Bastiat Page 17
